Income Inequality: It’s Hard Out There For the Rich (But Not the Very Rich)

The “middle-class rich” want the things that define middle-class America, and they want them in the country’s wealthy big cities. Meanwhile, the really rich are pulling away from them at an increasing clip. It’s no wonder they’re pessimistic.

By Whet Moser

Published March 12, 2012

Last week I highlighted a Chicago Fed report that, counterintuitively, found that in the wake of the Great Recession, people in higher income brackets are actually more pessimistic than anyone else about their expected future incomes. I’ve been thinking about some logical reasons for this, and one basic one leaps to mind: bonus compensation. If a substantial part of your potential annual income is wrapped up in bonuses, it can vary substantially, particularly in the event of market shocks or contractions. The same goes for investment income or stock options. In short, the incomes of the wealthy, in particular industries at least, are a lot more variable than that of the merely salaried. They still make a lot more money, but that income can fall by a substantial percentage, which normally isn’t the case for salaried employees.

Today I came across a 2009 paper by Northwestern economist Robert Gordon, “Has the Rise in American Inequality Been Exaggerated?” (PDF), and it offers some other possibilities for the pessimism of the wealthy. (Though the very wealthy should come away from it with no reason to worry.)

Schiff, 46, is facing another kind of jam this year: Paid a lower bonus, he said the $350,000 he earns, enough to put him in the country’s top 1 percent by income, doesn’t cover his family’s private-school tuition, a Kent, Connecticut, summer rental and the upgrade they would like from their 1,200-square- foot Brooklyn duplex.

“I feel stuck,” Schiff said. “The New York that I wanted to have is still just beyond my reach.”

Sometimes the rich circumvent reporters altogether and pen their own gripes. Here’s economist Brad DeLong, addressing a (now deleted) post by a University of Chicago law professor:

Professor Xxxx Xxxxxxxxx’s problem is that he thinks that he ought to be able to pay off student loans, contribute to retirement savings vehicles, build equity, drive new cars, live in a big expensive house, send his children to private school, and still have plenty of cash at the end of the month for the $200 restaurant meals, the $1000 a night resort hotel rooms, and the $75,000 automobiles. And even half a million dollars a year cannot [buy] you all of that.

For example, in Manhattan, after paying “millionaire’s tax” on everything from apartment purchases to income tax “surcharges", $150,000 per year for school (if you have four kids and want them to have a primary school education close to what you get for free in a decent suburb), send them for a few weeks of day camp in the summer for around $30,000–unless you want them to play video games all day, pay a mortgage on an apartment barely large enough to house the family (no one with a bedroom of their own) $100,000 year, pay $800/ month to park your car (no, not a luxury car), make some meaningful charitable contributions, etc. there is little left.

It’s notable that the examples above live in Manhattan, Brooklyn, and Hyde Park/Kenwood (the prof in question lives near the president, one of the nicer residential neighborhoods in the city). This is an important part of Gordon’s argument:

A stunning new data set undermines our previous conclusion (2008) that real income per capita has increased significantly in superstar bi‐coastal metropolitan areas. Very recently the Bureau of Economic Analysis has released data on price level differences across states, and this is the first time that a systematic sete of level differences has been published (as contrasted to long‐available measures of differences in CPI growth rates across cities). Without adjustment for price level differences, per-capita incomes in Massachusetts and New York are respectively 26.1 percent and 20.0 percent above the national average. With correction for regional price disparities, these percentages drop to 10.7 and ‐0.2 percent respectively.

In an important and related piece of research, Moretti (2008) notes that college graduates disproportionately cluster in metropolitan areas that have a high cost of housing. He finds that fully two‐thirds of the previously documented increase in the return to college between 1980 and 2000 vanishes when he corrects for differences in the cost of living across metropolitan areas. His cross‐area price measures are comprehensive and ingenious and take account of differences in housing costs, housing quality (i.e., smaller apartment sizes in New York than St. Louis), and price differences of non‐housing goods and services (pizza and haircuts are more expensive in New York).

Gordon does not go nearly as far as Moretti, tempering Moretti’s estimate that cost of living eliminates two-thirds of college ROI, taking into account other factors, may be closer to one-third.

Mariana proved us wrong. She not only lived in New York [in hip, expensive Park Slope] on a salary of less than $30,000 from a publishing-industry job, she managed to save $5,000 over the course of a year. On top of that, she stashed about $1,000 in her 401(k) account.

[snip]

A couple of times, Mariana says, she did some Dumpster-diving when she spotted a local market throwing out “big bags of bread perfectly packaged.” But for the most part, she saved money by eating lots of whole grains, beans, lentils, peanut butter and fresh vegetables from the food co-op. She ate meat a couple of times a week.

But you do have to be rich to be “middle class” in a big city, if by that you mean owning two cars, having a room for each member of the family (or even owning a house), and sending children to private school and summer camp. These things were doable for my middle-class family in semi-rural Virginia; in Chicago, you have to be middle-class rich.

And as Gordon argues, the rich are pulling apart within their elite income bracket:

Much of the within‐group increase in inequality in the bottom 99 percent occurred before 1993, whereas between 1993 and 2000 there continued to be an increase in the income share of the top one percent, and a continuing shift toward the top 0.1 and 0.01 percent groups within the top one percent segment.

Which brings us back to Brad DeLong:

Mr. Xxxx Xxxxxxxxx looks up. Of the 100 people richer than he is, fully ten have more than four times his income. And he knows of one person with 20 times his income. He knows who the really rich are, and they have ten times his income: They have not $450,000 a year. They have $4.5 million a year. And, to him, they are in a different world.

And so he is sad. He and his wife deserve to be successful. And he knows people who are successful. But he is not one of them–widening income inequality over the past generation has excluded him from the rich who truly have money.

Gordon notes that college graduates have flocked to big cities because that’s where the jobs for the college-educated are—teaching at elite research institutions, working in the financial markets, working in the biggest and most profitable law firms. And these big cities have become very expensive, leaving a lot of successful people in the position of being “middle-class rich.” Perhaps this shouldn’t raise anyone’s sympathies too much, but it’s worth keeping in mind the importance of perception. If the middle-class rich look up, they see people pulling away from them, particularly in the past 20 years, and being able to afford everything. If they look down, they see people with smaller incomes and smaller expenses being able to afford what they want. Their income is substantial, but their expecations are greater still—as is their pessimism.